Small business owners usually are fully aware of product differentiation, even if not by that name. Products in a retail store are different not only in terms of what they do for the consumer but also in quality and aesthetic considerations such as color or style. Understanding product differentiation and the difference between horizontal and vertical differentiation can help small business owners devise a solid strategy for developing and marketing their products.

Product Differentiation

Product differentiation is the business strategy of developing and marketing different kinds or styles of products. Producers differentiate their products in the market to establish or exploit competitive advantages and expand market share. How a company goes about differentiation varies considerably, from offering entirely new products and services to merely changing the design or color of a product. In either case, the company is looking to meet the needs of more consumers by offering them different products. There are two broad categories of differentiation -- vertical and horizontal.

Horizontal Differentiation

Horizontal differentiation refers to distinctions in products that cannot be easily evaluated in terms of quality. This stands in contrast to vertical differentiation, where the distinctions between products are objectively measurable and are based in the products' respective level of quality. Horizontally differentiated products vary only marginally, as it's more efficient for producers to try to capture as many new consumers as possible with minimal additional costs. While horizontally differentiated products tend to command similar prices at equilibrium, the lack of relationship to quality does not necessarily imply that they cost the same -- two products may be virtually identical in all considerations except for color or flavor and still be offered at totally different prices.

Subjective Preferences of Consumers

Unlike vertically differentiated products, the features of horizontally differentiated products cannot be ordered objectively. Common examples of horizontal differentiation include location -- offering the same products, but in different geographical areas -- or color -- offering the same products in different paint schemes, for instance. In another example offered by Teng Wah Leo of St. Francis Xavier University, "one car enthusiast may look first for the BHP (brake horsepower) for his truck; another may be more concerned with MPG (miles per gallon)."

Advantages and Disadvantages

Horizontal differentiation offers producers some key advantages, including the possibility of greater market share -- refrigerators offered in both white and black appeals to consumers with either preference, for example. Horizontal differentiation often is cheaper than improving quality, which is necessary for vertical differentiation. Offering too many options, on the other hand, may become inefficient due to the cost of producing new options. In addition, horizontal differentiation is not enough to acquire new customers if they are looking for higher levels of objectively measured quality or lower prices.